Lunatic idea of the week: why not take banks private?

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Felix Salmon notes that in the public mind, top earners=top executives.  In banking, at least, it doesn't work that way.  This means that capping pay on executives does not necessarily cap bonuses that seem to Joe Q. Public to be outrageously, outlandishly large.

When the US government started talking about paycuts for banks' "top executives", it seemed at the time that they were talking only about the top four or five C-suite officers of the company. When the press uses the term, however, it seems to mean "anybody at the company who makes a lot of money".

The WSJ reports that "David Gu, head of Merrill's global-rates division, made $18.7 million in 2008" -- but Gu doesn't even appear on Merrill's old "executive management team" list, which includes no fewer than 34 different names. Merrill's top earner, Andrea Orcel, is on the list, but only in 13th place. And I suspect that many of the 11 eight-figure earners were either on guaranteed bonuses or were traders with essentially no executive role in the company.

Which is not to say that they deserved their bonuses, of course. If the company you work for loses billions of dollars every quarter of the year, then you can't reasonably expect that company to give you a whopping great bonus, even if you personally did well.

From the employee's perspective, why not?  These guys don't think of themselves as part of Merrill; they're free agents.  They're at Merrill for the money, not because they have some great loyalty to the firm; they might as well be contractors.  I doubt Merrill's IT consultants offered to give back performance bonuses because the firm was having a bad year.  Besides, from their perspective, they kept a bad situation from getting worse.

The public wants these employees to identify with the firms, to accept the group responsibility for what happened.  And in the old partnership days, they probably would have felt some responsibility--a partner's fortunes rose and fell with his firm. (And in return, partnerships took care of partners whose production fell off).  But that 40+ year model of employment is gone.  Not just because people got greedy--though anyone who watched one of the banking houses go public can testify, the partners got greedy.  But because markets change too fast.  The current travails of GM workers illustrate what happens to people who bank everything on the fortunes of one firm.

In the case of banking, however, I might be willing to make an exception.  Pretty much everyone agrees that two of our biggest problems are, first, excess risk-taking by banks, and second, the existance of institutions that are too big to fail.  So why not force banks to operate the way they used to:  as partnerships?  I don't think that anyone believed they were creating the kind of massive systemic exposure we ended up with, and in fact the heads of the banks tended to have their personal fortunes tied up in the bank's operations.  But the lower level employees, the ones who actually knew what was going on in their trading books, didn't.  If the banks had been partnerships, I'm willing to bet that a lot fewer of them would have been tempted to lever up quite so far.

They also wouldn't have been able to get too big to fail; the rationale behind going public, other than sheer greed, was the ability to raise more capital.  We'd have a lot of little banks, no one of them big enough to take the whole system down with it.

I'm not saying that this would have been a panacea; it would have costs, of course, and some banks would probably still have failed.  But things might not have gotten so bad so fast if everyone hadn't had such huge incentives to make highly leveraged bets. 

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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